Practical Applications of Carry On

Practical Applications Summary

A frequent forward rate bias in foreign exchange markets enabled profits from carry trades for decades. Flying in the face of the efficient market hypothesis, this fact is generally regarded as a puzzle in finance. Yet since the global financial crisis, profitable carry trades are no longer prevalent. Past “abnormal” performance may have been compensation for risk rather than an anomaly. By focusing on the riskiest currency pairs, carry may continue to be a profitable strategy going forward.

In Carry On, published in the Fall 2019 issue of The Journal of Alternative Investments, Megan Czasonis, Baykan Pamir, and David Turkington (all of State Street Associates) explore what factors and circumstances favor a profitable carry trade and whether it can be a viable strategy going forward. They examine interest rate differentials, valuations, crowding, and volatility in relation to the performance of an FX carry trade portfolio. Their results provide some new pieces to the long-standing puzzle and valuable insights for investors.